What Does the Federal Reserve Think About When It Thinks About Alternative Small Business Financing?
August 27, 2015
The Federal Reserve Bank of Cleveland recently published results of a focus group it conducted on alternative small business financing. As part of the paper, the Fed included a brief discussion of some of the questions raised by the study. The considerations discussed offered an interesting glimpse of some the legal issues the Fed is thinking about in relation to alternative small business finance.
First, the Fed considered the increasing trend of bank referral partnerships and wondered if such referral arrangements raise disparate impact concerns under the Equal Credit Opportunity Act. It asked:
Do issues of disparate treatment arise if banks refer certain customers to their alternative lending partners, but offer traditional loan products to others?
The Fed’s question seems to suggest that a bank’s referral of some customers to alternative lenders over others could potentially be used against the bank in a disparate impact claim. The Fed’s comment is especially noteworthy given the recent Supreme Court decision in Texas Department of Housing and Community Affairs v. The Inclusive Communities Project, Inc. That decision approved the use of the disparate impact theory under the Fair Housing Act. Many observers had hoped the Court would find that such claims could not be brought under the FHA and thereby limit their use under other federal statutes, such as ECOA.
The Fed was also interested in the effect the use of automated underwriting systems is having on small business lending. It asked:
Does the use of automated underwriting raise or address fair lending concerns?
Unfortunately, the Fed did not specify in what ways it believes fair lending laws may be implicated by the use of automated systems. These concerns could include larger societal issues, such as the effect automated systems are having on credit availability. Or they may involve practical considerations, such as how lenders are meeting their disclosure requirements under ECOA given the increasing number of applications reviewed by automated processes.
While these questions are quite preliminary, they offer interesting insight about how regulators are thinking about the industry and the issues they’re focusing on.
Participate in Alternative Finance? You Might Want to Start Watching the Supreme Court
August 19, 2015
A trio of cases before the Supreme Court could have far reaching effects on alternative small business finance. Here’s a rundown of what to watch.
1. Texas Department of Housing and Community Affairs v. The Inclusive Communities Project, Inc. (Decided June 25, 2015)
In this case, the Court was asked to decide whether a disparate impact claim—a legal theory that allows regulators to bring discrimination claims against a defendant even where no intentional discrimination is alleged—could be brought under the Fair Housing Act. Many observers hoped the Court would find that such claims could not be brought under the FHA and nearby limit their use under other federal statutes such as the Equal Credit Opportunity Act. The Court, however, found that disparate impact claims could be brought under the FHA.
How does this affect alternative lenders?
The Dodd-Frank Act gave the CFPB authority to enforce ECOA, which is one of the few fair lending laws that apply to small business lenders. Some legal observers believe that the CFPB could potentially bring disparate impact claims under ECOA against alternative funders that the Bureau believes have engaged in policies that have resulted in discrimination. The Court’s decision may embolden the agency to bring future actions.
2. Hawkins v. Community Bank of Raymore (To be argued October 5, 2015)
ECOA prohibits lenders from discriminating against applicants on the basis of race, color, religion, national origin, sex, marital status, or age. It also requires lenders to provide applicants notice of any adverse actions taken by the lender in relation to the applicants’ request for credit. The Hawkins case asks the Court to decide whether guarantors should be included in the definition of applicant.
How does this affect alternative lenders?
If the Court determines that personal guarantors are included in the definition of applicant, guarantors would be entitled to the same protections and disclosures as business applicants. Lenders would be required to provide the primary business applicant as well as each guarantor with the appropriate adverse action notices in the event of a decline. Implementing procedures to comply with this requirement could require significant investment from alternative lender.
3. Madden v. Midland Funding, LLC (Appeal expected soon)
This case has been widely followed given its potential effects on marketplace lenders that use banks to originate their loans. The Madden court held that the usury preemption provision of the National Bank Act did not apply to non-bank assignees. Midland requested that the 2nd Circuit rehear the case en banc but that request was denied last week. Midland now has 90 days from the date of the denial to petition the Supreme Court to review the 2nd Circuit’s decision.
How does this affect alternative lenders?
As it stands now, Madden is binding in the 2nd Circuit. If the Supreme Court declines to hear the case, the denial will confirm that Madden is settled law. In that event, observers will be closely watching to see what effect Madden has on litigation involving marketplace lending as well as the purchase and sale of bank originated debt in the larger secondary markets. A recent case out of California may provide some early indications.
Reactions to the Treasury RFI: Business Lenders and Merchant Cash Advance Companies Share Their Thoughts
August 13, 2015
The Treasury Department could get an earful from the alternative funding industry during a 45-day public comment period on online marketplace lending that began July 17.
Treasury emphasizes that it isn’t a regulator and its Request for Information, or RFI, isn’t a regulatory action. The department just wants to hear success stories and opinions on potential public policy issues, a Treasury spokesman said.
“There isn’t a lot of data available on this industry,” the spokesman noted. “The RFI allows us to gather information from the public.”
One portion of the public – alternative funding executives – may have a lot to say on the subject. At least some of the industry’s top players favor regulation or legislation that could clean up the industry and clarify conflicting directives.
“Personally, I’d be glad to see it on the federal level,” Stephen Sheinbaum, president and CEO of Merchant Cash and Capital, said of regulation. “We won’t have to deal with 50 individual states, which is more unruly.”
Others would prefer to see the industry regulate itself instead of having federal agencies issue dictates or having Congress pass laws.
“I would like to put in my two cents,” said Asaf Mengelgrein, owner and president of Fusion Capital, indicating he intended to respond to the RFI. “I see a need for better practices, but regulation should come internally.”
Whoever makes the rules, restrictions seem inevitable because of alternative funding’s prodigious growth, executives agreed. “Regulatory attention is a sign of an emerging industry,” said Marc Glazer, president and CEO of Business Financial Services.
Regulation should curb the practice of stacking loans or advances, which can burden merchants with more financial obligations than they can meet, Sheinbaum said. Stacking has proliferated even though ethical members of the industry avoid it, he said.
At the same time, disclosure statements should become more transparent so that merchants can easily identify how much they’re paying in fees and expenses, Sheinbaum maintained. Merchants should also be able to see how much they’re paying the different entities involved in the deal, he said.
“I’m not suggesting someone should make more or less, but transparency is a healthy thing and this industry could use a little more of it,” Sheinbaum said.
The alternative-funding industry could follow the example of the mortgage business, where more-standardized forms help consumers compare competing offers, Sheinbaum said. “That’s not the case in this industry, so that might help,” he maintained.
The industry should not emulate the credit card processing business, which uses complicated and dissimilar contracts to keep customers uniformed, Sheinbaum said. “It’s not so easy for a merchant to understand the effective cost of a transaction – and that’s by design,” he said.
Reviewing those issues could confuse among regulators who don’t understand the industry, Mengelgrein warned. Someone “on the outside looking in” might consider the industry’s fees and factor rates outrageously high, but that’s because they fail to understand the financial risk involved with lending to small businesses, he said.
Before imposing rules, regulators should also bear in mind that many small businesses could not survive without alternative funding, Mengelgrein continued. In recent years banks have failed to step up and help merchants in need of cash, and the alternative lending community has filled the gap.
Sheinbaum agreed. “I hope the regulators and legislators will make an earnest effort to understand all the good that folks in the alternative finance space provide for people,” he maintained. “It’s a critical role we play in keeping small businesses going, and small business is important to this country.”
The Small Business Finance Association could play a critical role in helping government understand the industry, Sheinbaum suggested. He noted that the trade group changed its name from the North American Merchant Advance Association because the industry is adding loans to its initial offering of merchant cash advances.
Whatever shape regulation takes, the industry should keep up with the new rules, Glazer cautioned. “As this industry evolves, we will work closely with our partners and our customers to ensure that everyone is informed about any new regulations and the potential impact that they may have on our business,” he said.
Meanwhile, Treasury’s efforts to comprehend the business are continuing. Its RFI contains 14 detailed questions that respondents could address.
The department held a forum on Aug. 5 called “Expanding Access to Credit through Online Marketplace Lenders.” The event included two panel discussions and roundtable discussions with Treasury staff.
Attendees numbered about 80 and included consumer advocates, representatives of nonprofit public policy organizations and members of the financial services industry, the department said.
Are Your Sales Agents or ISOs Up to Snuff? (Take Our Research Survey)
August 12, 2015If you enjoy reading AltFinanceDaily’s articles, please take the time to take our short survey:
Some background:
What started as a few sensational articles about practices in small business lending and merchant cash advance is now turning into a cry for a governmental crackdown by not only observers outside the industry but lenders from inside the industry itself.
Stories that look like they’ve been written by consumer activist groups are being penned by your peers. Just recently, Fundera’s Brayden McCarthy submitted his thoughts to American Banker and the Huffington Post.
“As evidence,” he wrote. “One need only look to some lenders’ triple-digit interest rates, the proliferation of shady loan brokers and inadequate or nonexistent disclosure of price and terms. Some practices, such as brokers that brand themselves as impartial but take incentives to market certain lenders over others, resemble behavior seen in the run-up to the financial crisis.”
Along with the Treasury’s RFI, there is a mass lobbying effort to regulate the industry as fast possible. As Patrick Siegfried, Esq pointed out recently, former SBA Administrator Karen Mills recently urged the the CFPB to implement the Small Business Data Collection Rule of the Dodd-Frank Act, a law which could potentially outlaw the underwriting practices of the entire business lending and merchant cash advance industries.
There’s also been the publication of a Small Business Borrowers’ Bill of Rights and the formation of the Responsible Business Lending Coalition. And on Forbes, an interview with loan broker Ami Kassar described the industry as the wild, wild west.
As a long time participant and observer in the industry, (this is my 10th year now) I want nothing more than a bright and prosperous future for both my peers and America’s small businesses. I hope you’ll take two minutes to take our survey above.
Thanks!
Jeb Bush Owns Lending Club Notes
August 10, 2015Former Governor and Presidential Candidate Jeb Bush recently released thirty three years of tax returns, but included in his Office of Government Ethics Form 278e was a notable asset, Lending Club notes. Lending Club stock wouldn’t earn interest income so these are clearly the notes that any investor can buy on the platform. The value of the notes held was declared to be between $1,001 and $15,000 and the interest income between $15,001 and $50,000.
ABC News was the first to mention the asset but I am posting a photo of the actual line item.
The value of the notes held are so small, one has to wonder if Bush himself did the investing.
This was also stated about the asset at the end of the packet:
And another republican presidential candidate is a big proponent of Bitcoin. Back in April, I got to meet U.S. Senator Rand Paul at a Bitcoin event in NYC.
Between Bush and Paul, the republican candidates sure are shaping up to be FinTech friendly.
Are You Robodialing? The TCPA and FCC Scoop You Need to Know
July 2, 2015
In 1991, when Congress began regulating autodialers via the Telephone Consumer Protection Act, our phones and our relationships with them were vastly different from what that equipment and those relationships look like today. At that time, Congress was regulating a world without text messages and ubiquitous cell phones and a world where autodialers were infuriating consumers nationwide for their ability to generate and dial telephone numbers indiscriminately without regard for who was on the receiving end of the call.
In the intervening years, Congress has made modest TCPA amendments to address unsolicited faxes and nefarious manipulation of caller ID information, but it has otherwise failed to adjust the law to reflect the way we communicate today. The FCC has tried harder than Congress to update its TCPA rules, but it too has failed in this regard. The result is a set of obsolete standards whose significance vastly outpaces their sense due to the TCPA’s private right of action and rigid statutory damages calculation. Companies hoping the FCC would pivot toward sanity in its recent announcement of TCPA guidance are surely disappointed today.
The TCPA has always defined a regulated “autodialer” as equipment with the capacity to store or produce telephone numbers to be called using a random or sequential number generator and to dial such numbers. The FCC’s TCPA rules retain that formal definition, but the FCC has explained that predictive dialers and other equipment enhancing dialing efficiency are also regulated as autodialers because of their capacity to dial numbers without human intervention. The FCC has repeatedly confirmed that the focus of the “autodialer” standard is on the equipment’s capacity, not its actual use.
A number of courts have tried to make this “capacity” standard more concrete by limiting it to the equipment’s present capacity, that is, what the equipment was capable of doing when the calls at issue were replaced, without considering what the equipment could be reconfigured to do at some future time. These courts explained that a focus on present capacity was necessary to ensure that every person’s smartphone would not be regulated as an autodialer based on what it could be reprogrammed to do.
The FCC received a number of petitions seeking more formal, universal guidance on the TCPA’s “autodialer” standard. We are still waiting for the FCC to publish the guidance it has approved, but according to the FCC’s June 18, open meeting, that guidance will not make this issue any clearer. According to the FCC’s preview, that guidance will affirm that the TCPA’s “autodialer” standard focuses on the equipment’s capacity, ensuring that “robocallers cannot skirt consumer consent requirements through changes in calling technology design or by calling from a list of numbers.” If this is an accurate summary of the FCC’s guidance, it will do absolutely nothing to resolve the most pressing concerns on this issue. It will not address whether “click-to-dial” technology, which involves some human intervention but may have the capacity to operate without it, is regulated as an “autodialer.” It will not address whether the definition’s “capacity” element is limited to present capacity or also includes possible future capacity. The surge in private TCPA litigation makes these ambiguities treacherous.
Although the FCC discussion of its TCPA guidance touts the protections provided to consumers, the autodialer provisions apply equally to business-to-business calling. MCA companies must be aware of the TCPA’s autodialer requirements for B2B calling campaigns. They can be sued for improper calls placed to businesses, as well as errant B2B calls that are answered by individual consumers. The FCC’s TCPA rules establish that callers must have the call recipient’s “prior express written consent” for sales calls placed to cell phones using an autodialer or a prerecorded message. This form of consent requires a signed writing from the call recipient and requires certain “magic words” disclosures that must be provided when the consent is obtained. This consent requirement applies to B2B calls as well as B2C calls, and the existence of an established business relationship between the parties to the call does not provide any relief from this requirement. Non-sales calls to cell phones using an autodialer or a prerecorded message require “prior express consent.” This term is not defined, but the FCC has explained that a call recipient provides valid consent to a creditor by volunteering his or her cell phone number to the creditor, such as on a credit application. There are tricky details in this standard, so MCA companies should proceed with caution in order to establish valid TCPA consent.
Technology makes our lives easier, but it makes our TCPA compliance analysis more complicated. The TCPA should not impede technological developments that do no harm, but the law’s enforcement scheme encourages “professional plaintiffs” and greatly increases the likelihood that a TCPA violation will result in a lawsuit. The FCC is presently fumbling an opportunity to address this. It’s unclear when another such opportunity will arise or what it will take for the FCC to decide to align its TCPA rules with the real world.
Merchant Cash Advance: Do You Know What You’re Selling?
June 22, 2015
Continuing on with the Year of The Broker discussion, I want to now shift focus to the continued wave of new broker entrants that are not receiving sufficient training. I don’t believe that it’s so much the fault of the brokers, as it’s the fault of the companies they are reselling for. Those companies usually fail to provide a structured training regime. Training provided to new broker entrants is typically centered around the memorization of sales scripts, the practice of outdated rebuttals, and the repetition of lines that can end up sounding very canned and robotic.
If I had to recommend new age sales training, I’d have to go with my favorite, which is Diagnostic Selling, promoted by the likes of Jeff Thull from Prime Resource Group (www.primeresource.com). Thull explains that as the sales consultant, you should be a valued source of business advantage for your client, rather than just a person that goes through a series of sales material regurgitation. You should have access to products, services, platforms, big data, knowledge, key players, new solutions, forecasts, trends, etc., that the merchant does not have access to, which allows them to see you as a “valued extension” of their organization. This leads to not just new client acquisition, but the real key to making money in our space, and that’s client longevity.
In order to truly achieve this level of sales consultancy, it’s important that you truly understand the products being sold because, firstly, you want to be able to distinguish between the products you are selling so that you can provide a valued consultation. You might find yourself selling one product when you should be referring another. Secondly, understanding these products is important from a regulatory standpoint as the legal connotations of the products must be disclosed properly or mistakes in disclosure, marketing, or funding agreements could become costly.
If you are an independent broker in the alternative commercial lending space, you are usually going to be selling one or multiple of the following products:
- The Merchant Cash Advance
- The Alternative Business Loan
- Equipment Leasing
- Accounts Receivable Factoring
- Accounts Receivable Financing
- Purchase Order Financing
To begin, let’s discuss the Merchant Cash Advance…
Product Value Points
Don’t Let The Critics Win
Critics of the product focus mainly on its high cost and it can be very expensive, but when used properly the product is a great leveraging tool.
Critics fail to shed light on the value of the product in terms of the merchant’s usage. Going back to that Growth Investment example, if the product had not been available, then what were the other sources available for the merchant to take advantage of the growth opportunity? In actuality, there were no other credible sources. Had the Merchant Cash Advance not been available, that investment would not have been made, and a ton of national, state and local economic activity would not have taken place, such as:
- The Equipment Manufacturer’s sale of the equipment
- The Merchant’s generation of $300,000 in revenue based on having the equipment
- The Purchaser’s revenue from borrowing costs incurred from the client using the advance
- My individual commission
- Then all of the federal, state and local taxes that would have been paid as a result
All of that economic activity vanishes if said transaction does not take place. Despite the high cost of the product, the fact is that this transaction would have been a win across the board for all parties involved including the Manufacturer, the Client, the Purchaser, Myself, as well as the Federal/State/Local Government. The true value of business capital, no matter if it’s conventional or alternative, is that the capital should produce enough new revenues so that it truly pays for itself.
Mayor Rahm Emanuel Declares War on Merchant Cash Advance
January 16, 2015
FOX 32 in Chicago is reporting that Mayor Rahm Emanuel is going on the offensive against merchant cash advance companies. Specifically it says,
Mayor Rahm Emanuel will call on state and federal agencies to regulate business to business lenders. Emanuel said cash advance companies have accelerated their marketing efforts in recent months, resulting in small businesses taking loans they cannot afford.
The article states that business owners have turned to the City of Chicago for help in paying back loans with high rates of interest.
While the mention of APRs reaching into the ranges of triple digits is supposed to shock you, one business lender that charges such rates recently went public and had been backed by Google Ventures, Fortress Investment Group, Goldman Sachs, and Peter Thiel.
Less than 30 days ago we were celebrating these companies as the solution to a problem that has plagued small businesses for all time, access to capital.
While Emanuel is obviously famous for being the 23rd White House Chief of Staff and Obama’s right hand man for a period in his first term, he is not the first mayor to consider the role merchant cash advance companies and high interest business lenders have in cities across America.
All the way back in 2008, the U.S. Conference of Mayors (USCM) adopted a resolution titled, Protecting Main Street Small Business Owners from Predatory Lenders, from which some of the excerpts below are from:
WHEREAS, merchant cash advance companies have already lent approximately $2 billion at egregious rates and have been quoted in leading main stream media publications such as Forbes, Business Week, Dallas Morning News, and American Banker claiming that their new originations have increased 75% in the first half of 2008
WHEREAS, as with payday lenders and predatory lenders in the home mortgage community, Mayors need to take a leadership role to scrutinize predatory merchant cash advance companies, educate small business owners of the dangers posed by these firms, and increase awareness and promotion of alternative, more affordable funding sources to support this vital segment of our economy
BE IT FURTHER RESOLVED, that to protect the general health and viability of their small business communities, cities should investigate whether they can effectively regulate or ban merchant cash advances.
3 months after this resolution was passed, Lehman Brother’s collapsed and the economic crisis was in full swing.
According to a few industry leaders familiar with the 2008 mayoral resolution, UCSM privately retreated from their stance when all other types of commercial lending had dried up. Their seeming reversal, though not publicly stated invited merchant cash advance companies into their communities at the moment when Main Street was arguably at its weakest.
Who do they think rolled up their sleeves and kept local economies alive when things were at their worst?
While non-bank funding can obviously be expensive, countless business owners have praised merchant cash advances in particular as a solution that came through when none other were available.
Emanuel will learn that companies such as Square and PayPal are part of the crowd that provides merchant cash advances. This is not a shadow industry. Non-bank business-to-business financing is already becoming less expensive nationwide.
According to Fox, the Commissioner of the Chicago Department of Business Affairs and Consumer Protection said the goal is to offer small business owners loans at affordable rates with full disclosure.
Merchant cash advance companies would undoubtedly feel the same way. The dilemma is that advocates of affordable rates tend to really mean single digit rates. When single digit rates are not possible given the risk, they seem to argue that no financing should be given at all, leaving the business to fail or miss out on an opportunity. That’s the exact type of flawed thinking alternative financing companies address…
Ironically, a report from the Federal Reserve Bank of Cleveland last week concludes that small business job creation is lagging with a possible culprit being a lack of access to credit.
Coming out of the most recent recession, however, job creation by small businesses has lagged, and the new business formation rate continues to fall. While it is not clear that these trends are driven by weaker borrowing or limited access to loans, it is evident that businesses need adequate credit to succeed and grow. As such, policy makers should not lose sight of the trends related to small business credit, even with the recent positive reports showing improvements.
And of course in a supposed exposé on merchant cash advances that aired on Chicago Public Radio in November, clips of an interview I did with them were aired to fit the narrative of merchant cash advance as predatory. When asked by the interviewer what a small business owner should do if they didn’t understand a contract, I advised that they hire an attorney or an accountant, and if they couldn’t afford those then to find somebody they felt qualified to offer an opinion. “They should always get a 2nd set of eyes to review a contract if they don’t understand,” I said.
My advice did not air, nor did my explanation that there were two separate types of products that they were confusing as one, one being loans and the other being purchases of future receivables. I suppose it didn’t fit the characterization they were going for.
As quoted in Fox, Financial Advisor Kent Travis advised business owners to “read the documents, don’t sign anything on the spot, make sure you read it thoroughly and if you have trouble understanding it seek the advice of an advisor, CPA, an attorney or a financial planner.”
I couldn’t have said it better myself because I already did.
And in an interview I had with former Congressman Barney Frank, a chief architect of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Frank voiced his opposition to regulations on business-to-business lending in early 2014.
There’s one thing the Fox story does mention that’s hard to argue with and that’s the need for greater transparency. I am all in favor of that.
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For those that haven’t already signed up, this is a reminder that the Law Office of Pepper Hamilton LP is hosting a lunch at their office in New York on January 27th to specifically discuss the merchant cash advance industry’s future.
Interested in discussing legal issues, best practices, and the path forward for alternative business financing? Are you an ISO or funder interested in sharing your thoughts? Send me an email to let me you know if you’d like to attend. sean@debanked.com.
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Watch the Fox news report about merchant cash advances:
